Investment advisors should buy stocks, funds they promote to their clients

By DAVID MOON, Moon Capital Management
August 12, 2001

Each year, the US Army packs thousands of parachutes for use by its soldiers around the world. These chutes are packed by men and women who are specialists, trained precisely for that mission. After each chute is packed, the specialist signs a tag affixed to the pack. Another specialist then checks the chute and also signs his or her name to the work. Here is the best part: at least once each month, an Army supervisor will instruct a packer or checker to leave the work station with the chute he just completed packing, go directly to a waiting airplane and jump with that parachute. The packers never know when this will happen, but they know it will happen. They must be willing to jump with any parachute they pack. Sounds like pretty good quality control.

The investment industry could learn a thing from the Army.

The very first question an investor should ask a potential advisor is about his own investments. Does the advisor eat his own cooking? If not, why not?

Registered investment advisors must complete a Securities and Exchange Commission disclosure document, detailing business practices, history, processes, fees and other information. One of the questions on the form is whether or not the advisor also purchases for herself securities she recommends to clients. The tone of the question suggests this particular practice is a red flag. In fact, the opposite is true.

On our disclosure document, we proudly indicate that we do buy for our own accounts securities we recommend to clients. In fact, most of our employees' personal wealth is invested in a fund we manage, identically alongside our clients. This is a bad thing?

Of course, it would be a bad thing to buy the same securities as your clients if the advisor was buying or selling his stock at better prices than his clients. That defeats the purpose of forcing a manager to jump with a chute he just packed. 'Let's wait and see if the chute opens before deciding whether to put a client in it or wear it myself.'

CNBC commentator, Jim Cramer, last week noted that on many occasions, 'analysts' on television strongly recommend a stock to viewers at the same time they were trying to sell it themselves. If that has happened, the network should tell the viewers and disclose the names of the offenders. The SEC should purchase full-page ads in the Wall Street Journal telling investors of these specific acts of malfeasance. 'The following firms take advantage of their clients and have a demonstrated and proven willingness to screw their clients if there is enough money involved and the odds of getting caught are low.' That would be an effective SEC disclosure.

After years of standing on my soap box about the Wall Street analyst industry, the issue is finally more popular in the mainstream. CNBC now asks its guests if they own the stocks they tout on air. The analysts proudly and smugly uniformly reply, 'no.' The CNBC commentators then continue with their interview, comfortable in the ethics of the situation. Instead, I want Liz Claman to ask an analyst why he DOESN'T own a stock he recommends as a good buy. Then I would ask if the analyst ever owned the stock. That might be interesting. Did the analyst used to own it, but sold it? At what price? And now he is recommending it to viewers and clients? And if the analyst/manager still owns that stock, I want to know when he bought it and what he paid for it.

One of the conditions of going on television (or into a client meeting) and making an investment recommendation should be that a supervisor can walk around and occasionally force the investment professional to immediately buy a bunch of whatever he is recommending at that moment. Make 'em jump with their own chute.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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